I OVERVIEW OF M&A ACTIVITY
Globally, 2015 was a year of mega-deals, and the UK M&A market has been no exception. Across Europe, buoyed by these high-ticket deals, total deal value topped the €1 trillion mark, easily surpassing post-crisis highs. The UK accounted for over 58 per cent of this deal value.2
In the UK, public M&A was a driver of much of this increase in activity. Fifty-two firm offers were announced for Main Market or AIM companies in 2015, up from 48 in 2014. As reported in the ninth edition of The Mergers & Acquisitions Review, there has been a trend for higher-value deals. Thirty-two offers were for Main Market companies (compared to 24 in 2014 and nine in 2013) and 14 offers had a value of over £1 billion (compared to nine in 2014 and three in 2013).3 This trend has been replicated across Europe, with transaction values increasing by 47 per cent despite a lower volume of transactions.4
In the face of political uncertainty surrounding the outcome of the 2015 general election and the referendum on the UK’s continued membership of the European Union, these figures appear particularly strong. The threat of ‘Brexit’ lowered business confidence, and in turn depressed dealmaking in the first quarter of 2016.5 In the wake of the leave vote, this political and ceconomic uncertainty is unlikely to be resolved any time soon and may affect the markets in the coming months.
The standout UK deal of the year has been Anheuser Busch InBev SA’s offer for SABMiller plc, announced in November 2015. This £71 billion transaction, discussed in further detail below, was an example of the trend in high-value M&A to implement a public offer through a scheme of arrangement. As in previous years, the scheme of arrangement was the most popular way of implementing bids and was used on 35 of the firm offers in 2015, compared to only 17 contractual offers. As mentioned in the ninth edition of The Mergers & Acquisitions Review, there was some discussion among practitioners about whether the regulation of reduction schemes to eliminate any stamp duty benefit would increase the use of the contractual offer. If anything, the scheme has become a more popular way of implementing a transaction. This is no surprise given its advantages over a contractual offer, such as being able to ensure 100 per cent control of the target. However, the contractual offer is still the only practical way to implement a hostile takeover, with three such bids occurring in 2015.6
Moving into 2016, the market has become somewhat subdued. There have been few of the mega-deals that characterised 2015. The highlight of the year so far has been Deutsche Boerse’s and London Stock Exchange’s proposed £21 billion ‘merger of equals’, an attempt to consummate a merger that had been mooted twice previously.
In 2015, the UK’s macroeconomic performance was solid if not spectacular. GDP growth was at 2.2 per cent compared to 2.9 per cent in 2014, while inflation struggled to enter positive territory in the face of the collapsing oil price and a strong pound. As remarked upon in the ninth edition of The Mergers & Acquisitions Review, productivity growth remains very low, and it is at 14 per cent below where it should be based upon pre-downturn trends.7
II GENERAL INTRODUCTION TO THE LEGAL FRAMEWORK FOR M&A
The Companies Act 2006 (2006 Act) provides the fundamental statutory framework and, together with the law of contract, forms the legal basis for the purchase and sale of corporate entities in the UK. In addition, the City Code on Takeovers and Mergers (Takeover Code, or Code) regulates takeovers and mergers of certain companies in the United Kingdom, the Isle of Man and the Channel Islands. The Takeover Code has statutory force, and the Takeover Panel has statutory powers in respect of the transactions to which the Takeover Code applies. Breach of any of the Takeover Code rules that relate to the consideration offered for a target company could lead to the offending party being ordered to compensate any shareholders who have suffered loss as a consequence of the breach. In addition, breach of the content requirements of offer documents and response documents may constitute a criminal offence. The Panel also has the authority to issue rulings compelling parties who are in breach of the requirements of the Takeover Code to comply with its provisions, or to remedy the breach. These rulings are enforceable by the court under Section 955(1) of the 2006 Act. The Code has a wider scope than the EU Takeovers Directive, and applies if the offeree (or potential offeree) is a UK public company and, in some instances, if the company is private or is dual-listed.
The Financial Services and Markets Act 2000 (FSMA) regulates the financial services industry and makes provision for the official listing of securities, public offers of securities, and the communication of invitations or inducements to engage in securities transactions. Following the substantial amendments to the FSMA, brought about on 1 April 2013 when the Financial Services Act 2012 (FS Act) came into force, financial regulation in the UK is split between two new bodies: the Financial Conduct Authority (FCA), which regulates conduct in retail and wholesale markets, and the Prudential Regulation Authority, which is responsible for the prudential regulation of banks and other systemically important institutions. As a consequence of the FS Act, over 1,000 institutions (including banks, building societies, credit unions and insurers) are now ‘dual-regulated’. The FSMA also established a regime to prevent market abuse. The UK Listing Authority Sourcebook of Rules and Guidance (which includes the Listing Rules, the Prospectus Rules, and the Disclosure and Transparency Rules (DTRs)), promulgated by the FCA in its capacity as the UK Listing Authority (the competent authority for the purposes of Part VI of the FSMA), includes various obligations applicable to business combinations involving listed companies, and contains rules governing prospectuses needed for public offers by both listed and unlisted companies. The Listing Rules, in particular, set out minimum requirements for the admission of securities to listing, the content requirements of listing particulars and ongoing obligations of issuers after admission. The Criminal Justice Act 1993, together with the Listing Rules, the DTRs and the Takeover Code, regulate insider dealing.
The merger control rules of the United Kingdom are contained in the Enterprise Act 2002, although the rules do not generally apply to mergers in relation to which the European Commission has exclusive jurisdiction under the EU Merger Regulation. In addition, specific statutory regimes apply to certain areas, including water supply, newspapers, broadcasting, financial stability, telecommunications and utilities, and these separate regimes may have practical implications in merger situations.
III DEVELOPMENTS IN CORPORATE AND TAKEOVER LAW AND THEIR IMPACT
i Takeover Panel: Practice Statements on offer-related arrangements and the provision of equal information to all offerors and potential offerors
On 8 October 2015, the Takeover Panel Executive published new Practice Statements No. 29 and No. 30, and withdrew Practice Statements No. 23 and No. 27 (the relevant contents of which have been incorporated in new Practice Statement No. 29).
Practice Statement No. 29 relates to Rule 21.2 of the Code, which prohibits offer-related arrangements between the target (or its concert parties) and the offeror (or its concert parties) during an offer period or when an offer is reasonably in contemplation. Rule 21.2 of the Code was introduced as it was becoming standard practice to include deal protection measures in offer-related arrangements that deterred competing offerors from making an offer.
The purpose of Practice Statement No. 29 was to provide guidance on the Panel Executive’s interpretation and application of Rule 21.2, and to clarify the Panel Executive’s position on certain exclusions to the prohibition on offer-related arrangements provided for in Rule 21.2(b) of the Code. These exclusions to Rule 21.2 are often utilised in agreements between an offeror and the target relating to the conduct, implementation and terms of an offer (otherwise known as ‘bid conduct’ or ‘cooperation’ agreements). In Practice Statement No. 29, the Takeover Panel has made it clear it should be consulted at the earliest opportunity if there is any doubt that a provision of a bid conduct agreement is in compliance with Rule 21.2.
In addition, Practice Statement No. 29 sets out the circumstances under which reverse break fees payable by an offeror to a target are allowable under the Code. Finally, Practice Statement No. 29 also clarifies the situations in which a target may agree to pay an inducement fee to an offeror in circumstances set out in Note 1 (competing offerors) and Note 2 (formal sale process) to Rule 21.2 of the Code.
Practice Statement No. 30 relates to Rule 20.2 of the Takeover Code, which requires the provision of equal information to all offerors or potential offerors. This Practice Statement provides guidance on how Rule 20.1 may be satisfied in circumstances where a target provides a limited amount of commercially sensitive information to competition or regulatory lawyers or economists advising an offeror on an ‘outside counsel only’ basis in relation to the potential need to obtain the consent of a competition authority or other regulatory body (but where such information is not provided to the offeror itself).
ii Takeover Panel: changes to the treatment of dividends in calculating the offer price
On 23 October 2015, the Code Committee of the Takeover Panel published a response statement (RS 2015/1) containing its feedback and final rules on its proposals in a previous consultation paper (PCP 2015/1) relating to dividends. The Code was changed to require an offeror to state, in any announcement regarding the terms on which an offer might be made, firm offer announcement or offer document, that it will have the right to reduce the offer consideration by the amount of any subsequent distribution (including a dividend) by the target, unless the offeror expressly states that target shareholders will be entitled to receive all or part of a specified dividend in addition to the offer consideration. This is of particular importance in mega-deals that characterised M&A activity in 2015. The often-lengthy gap between announcement and completion means that offeree companies may well have planned a distribution during this period. Increased gaps between announcement and completion are likely to become more of a feature as regulators, at both the UK and EU level, scrutinise more transactions.
The Code was also amended to require an offeror that has made a ‘no increase’ statement to reduce the offer consideration by the amount of any subsequent distribution by the target, unless the offeror has stated that target shareholders will be entitled to receive all or part of a specified distribution in addition to the offer consideration. There were also consequential amendments to clarify the impact of distributions on a minimum offer price established by stake-building purchases before or during the offer period.
The Code changes came into effect on 23 November 2015.
iii Takeover Panel: changes to the circumstances in which parties act in concert
On 14 July 2015, the Code Committee of the Takeover Panel published a consultation paper (PCP 2015/3) on the definition of acting in concert, and on 23 October 2015 it published a response statement (RS 2015/3) in relation to that consultation. The amendments, which came into effect on 23 November 2015, have changed the Takeover Code’s definition of ‘acting in concert’ to add three new presumptions. These are that:
- a a person, the person’s close relatives, and the related trusts of any of them, are all acting in concert;
- b the close relatives of a founder of a company to which the Code applies, their close relatives and the related trusts of any of them, are all acting in concert; and
- c shareholders in a private company who sell their shares in exchange for new shares in a company to which the Code applies, or who become shareholders in a company to which the Code applies following the re-registration of that private company as a public company, are acting in concert.
The new presumptions reflect and codify the Panel Executive’s previous practice. While it is possible in theory for any of the new (or previously existing) presumptions to be rebutted by the persons concerned in consultation with the Panel, in practice it is extremely difficult to do so.
The definition of acting in concert is of particular importance in relation to Rule 9 of the Code. This requires any person who, with the persons acting in concert with him or her, acquires interests in shares that carry 30 per cent or more of the voting rights to make a mandatory offer for the company. The third new presumption is of most importance. If the presumption is not rebutted upon an initial public offering where the initial shareholders retain more than 30 per cent of their shares, the same shareholders will be required to make an offer for that company if they subsequently acquire any additional shares.
iv Persons with significant control register
As noted in the ninth edition of The Mergers & Acquisitions Review, the Small Business, Enterprise and Employment Act (SBEE Act) received Royal Assent on 26 March 2015. Although its title suggests that it will only affect small businesses, the SBEE Act implements substantial changes to company law and corporate governance that will impact on all companies.
One such change is the introduction of the ‘Persons with Significant Control’ register (PSC register). Since 6 April 2016, UK companies and limited liability partnerships are required to hold, and maintain, a register of people with significant control. From 30 June 2016, they are required to file the information with Companies House. This forms part of a suite of measures reflecting the government’s commitment to increase transparency of company ownership and control.
People with significant control are individuals who hold (directly or indirectly) 25 per cent of a company’s shares or voting rights; control rights to appoint or remove a majority of the board; or otherwise have the right to, or actually do, exercise significant influence or control over the company. The Department for Business Innovation and Skills has issued statutory guidance on the meaning of ‘significant influence or control’.8
Importantly, publicly traded companies on UK exchanges are exempt, as are companies traded on an EEA regulated market or on specified markets in Switzerland, the United States, Japan and Israel.
The new regime will also impact upon private equity structures. Following consultation with the British Venture Capital Association, the government’s initial proposals for the PSC register were amended so that limited partners will not be registered on the PSC register solely because they are limited partners of a limited partnership. This amendment is welcome relief for the private equity industry, which commonly makes use of limited partnerships in investment structures. However, the exemption only applies in respect of limited partnerships registered under the 1907 Act (and would exclude, therefore, limited partnerships registered in other jurisdictions, including Jersey and Guernsey). Practitioners will need to be mindful of the increased transparency that will apply in transactions making use of such structures.
More generally, the PSC register may impact overseas companies acquiring UK subsidiaries. Overseas companies with UK subsidiaries (but not those that only have UK branches) need to be aware of the regime, as each of their UK subsidiaries will be required to keep a PSC register and, as with any other company within the scope of the regime, will need to obtain the information needed to complete the register.
v The EU Regulation on Market Abuse (MAR)
The UK’s civil market abuse regime aims to ensure the smooth functioning of the market for financial securities by curbing behaviours that distort the price of securities and harm investor confidence in the integrity and impartiality of the market.
At the EU level, concerns about market distortion arising through regulatory arbitrage have led to the introduction of new harmonising measures in the form of MAR. MAR will have direct effect in all EU Member States, including the UK, and most of its provisions will apply from 3 July 2016.
Although MAR bears many similarities to the UK’s existing regime, there are key differences that expand the scope of the market abuse regime, and change permitted behaviours and the ways in which listed companies need to operate within safe harbours. There are also changes to the rules governing the disclosure and control of inside information and the reporting of transactions by persons discharging managerial responsibilities.
There is some uncertainty about how MAR will be interpreted by the FCA as there has been limited guidance from both the FCA and the European Securities and Markets Authority on how MAR will be implemented. As a result, it remains to be seen what the extent of the impact of MAR will be.
IV FOREIGN INVOLVEMENT IN M&A TRANSACTIONS
As with the dramatic increase in mega deals in 2015, the UK saw a bumper year for foreign direct investment (FDI) in 2015. The UK again established itself as the market leader for FDI in Europe, with its European market share increasing to 20.9 per cent. This comes in a European market that itself grew 14 per cent in 2015. The number of FDI projects in the UK hit record levels for over a decade, with 1,065 projects in 2015, a 20 per cent increase on the previous year. These projects are estimated to have produced 42,000 jobs, a 35 per cent increase on FDI job production in 2014.9
In respect of M&A, 2015 again saw some extremely large-value acquisitions of UK companies by foreign investors, notably the acquisition of Allergan by Actavis, which completed in March 2015, creating the US$23 billion Growth Pharma. There were 24 successful acquisitions of UK companies by foreign investors in Q4 of 2015. While the numbers and value of acquisitions of UK companies by foreign companies were relatively stable in 2015 (28 in Q1; 29 in Q2; and 33 in Q3), the Q4 figure represents the lowest number since Q2013 (19) and is 37 per cent lower than the previous quarter.10
This drop in acquisitions is likely to be explained by the 23 June 2016 referendum in the UK on the question of whether to remain a member of the EU. The uncertainty of the UK’s position of easy access to the European Single Market gave foreign investors good reason to be wary. The full impact of the result of the UK referendum on EU membership is unlikely to be clear even in the aftermath of the vote, and only 36 per cent of investors surveyed by EY expect the UK’s attractiveness to improve in the next three years.11
Despite this uncertainty, substantial M&A of UK companies by foreign investors were announced in 2015. Examples include the announcement of Belgian–Brazilian AB InBev’s US$106 billion merger with British brewer SABMiller to create the world’s largest brewer, and the merger between Irish and British online bookmakers Paddy Power and Betfair with an estimated combined value of £5 billion.
The US continued to be the largest foreign investor in UK FDI in 2015, with 332 projects in 2015. However, emerging markets are beginning to have significant impact in UK foreign investment, with the biggest proportional surge in UK investment coming from China with 68 FDI projects originating in that jurisdiction in 2015, a 78.9 per cent increase on the previous year. Indian investment increased by 57.9 per cent from 2014, with 60 FDI projects, with the UK asserting itself as the clear leader for Indian investment in Europe.12
V SIGNIFICANT TRANSACTIONS, KEY TRENDS AND HOT INDUSTRIES
As noted in the previous edition of The Mergers & Acquisitions Review, the tax inversion, where US incorporated entities reincorporate in lower tax jurisdictions, is not new, despite a recent spate of such transactions. Unlike many other economies, the US continues to tax domestic corporations on their worldwide income, including income attributable to non-US subsidiaries. The regime, therefore, creates a strong motivation for US multinationals to avoid repatriating non-US profits to the US. For some companies, this means sitting on large cash piles outside of the US, in the case of Apple totalling over US$200 billion, rather than facing the US tax consequences.13 For other companies, the solution has been to enter an inversion transaction.
In 2015, the highest-profile tax inversion announced was that of Pfizer Inc and Allergen plc. The deal was valued at US$160 billion, making it the largest deal since the financial crisis and the third-largest piece of M&A ever undertaken. Although not involving a UK company, the clampdown by US authorities in November 2015 and April 2016 make this merger of particular importance to the inversions market.
Under the previous rules, a US company seeking to restructure under a non-US holding company had to ensure that a merger with a non-US incorporated counterparty resulted in the counterparty’s former shareholders owning more than 20 per cent of the combined group. The rules also restricted the ability to manipulate the sizes of the US and non-US business to reach the targets. In addition, if the shareholders in the US incorporated entity will own more than 60 per cent of the new non-US holding company, then the transaction will fall under further limitations set out by the IRS in 2014.
A wave of further regulation began in November 2015, preventing structuring deals with a holding company in a third jurisdiction, among other things. The April 2016 regulations curbed the use of earnings stripping – intercompany loans that reduce the US tax bills. It was these later changes that significantly reduced the tax benefit driving the Pfizer Inc/Allergen plc deal, killing the deal off. However, another high-profile inversion, the merger of Johnson Controls Inc and Tyco plc (an Irish incorporated plc) – and announced in January 2016 was not affected by these rule changes.
Despite the UK becoming an increasingly attractive tax jurisdiction, it seems likely that this latest set of guidance will decrease dealmaking in this area even further in 2016, although, as Johnson Controls Inc/Tyco plc shows, there will still be transactions that escape the stringent new rules.
ii Financial services and insurance
The financial services sector has faced a challenging 2015 and start to 2016. With the capitalisation of European banks back in the spotlight, and the continuing fallout from misconduct and scandal, dealmaking by banks has been slow.
However, the largest and most interesting public takeover announcement of the first quarter of 2016 came from another area of the financial services sector. The £21 billion proposed ‘merger of equals’ between Deutsche Boerse and London Stock Exchange is an attempt to consummate a merger that had been attempted twice previously. The deal would create the world’s biggest exchange operator by revenue and the second-largest by market value. If completed, the deal is intended to achieve savings for customers of LCH.Clearnet (which is majority owned by LSE), and Deutsche Boerse’s futures-clearing business will be achieved by reducing the collateral that they need to hold across the two institutions.14 Synergies for the new merged entity will be achieved through, inter alia, a merger of the IT systems and certain back office functions.
However, the deal faces significant regulatory hurdles despite having been given the go-ahead from the UK and German regulators. The French regulator is particularly concerned that the new merged entity will pose a competition problem due to its dominant position in the derivatives clearing market. The extent to which this a political move by French regulators keen to avoid a shift of financial power to London and Frankfurt is unclear.
An area that could prove a hotspot for dealmaking in 2016 is that of the challenger banks looking to shake up the established big four or five UK banks. These banks are expected to see growth amid government and regulatory intervention in the sector to encourage competition.
iii Anheuser Busch InBev’s takeover of SABMiller
The standout deal announced in 2015 was AB InBev’s takeover of SABMiller. The takeover, if successful, will likely mark a high-water point of consolidation in the brewing sector that has come under pressure in recent years from craft and microbrewers. The deal will result in an entity that will brew 80 billion litres of beer a year and will generate more than US$70 billion of revenue. The deal, valued at £71 billion, was the largest transaction announced in 2015, aside from the aborted merger of Allergen plc and Pfizer Inc. The transaction will be implemented through a three-stage process involving the acquisition of SABMiller by a Belgian NewCo; AB InBev making a cash takeover offer for all of the shares issued to SABMiller shareholders; and AB InBev merging with the Belgian NewCo, which will have a primary listing in Belgium, as well as secondary listings in Johannesburg, Mexico City and New York.
Although the size of this transaction immediately catches the eye, there were two further interesting points about the deal. First, AB InBev could raise a US$75 billion syndicated loan, the largest ever, to fund the acquisition without a mandated lead arranger.15 Second, it precipitated the second-largest deal in the consumer sector, as SABMiller sold its 58 per cent stake in the Miller Coors joint venture for €11.8 billion to Molson Coors Brewing. As competition regulators in Europe and the US become more active, back-to-back divestments, such as those in the SABMiller/AB InBev deal, will become an even more significant part of big ticket M&A.
VI FINANCING OF M&A: MAIN SOURCES AND DEVELOPMENTS
i Public M&A financing
In 2015, 52 firm offers were announced for AIM or Main Market companies that were subject to the Takeover Code. Of these offers, 90 per cent included cash as the only form of consideration, or in combination with shares or loan notes, or with a loan note, partial share or unlisted securities alternative, or as a partial alternative. Of those offers, 12 (16 per cent) were financed by the bidder’s available cash resources alone, a decrease on the 2014 figure of 20 offers (49 per cent). The upward trend of using debt finance to fund bids continued in 2015, with 33 of the 52 bids involving debt (including four bids involving senior notes issues) to fund the bid (63 per cent), compared to 18 out of 42 bids in 2014 (43 per cent). In four out of the 52 offers, the cash consideration was financed by the bidder by way of an equity issue.16 There were no bids involving equity financing in 2014.17
As in previous years, the Takeover Panel Executive exercised its discretion to grant a limited dispensation from 26.2(b) of the Takeover Code. Rule 24.3(f) requires that the offer document must contain a description of how and through which sources the offer is to be financed, and Rule 26.2(b) states that any documents relating to the financing of the offer are published on a website no later than 12 noon on the business day following the firm intention announcement. Where financing agreements contain a market flex provision, publishing the upper limit of the flex (i.e., the threshold within which the lead arranger has the capacity to alter certain provisions of the loan) would give potential syndicates an advantage in negotiating their terms of entering the syndicate, and push pricing to the higher end of the flex. Accordingly, the Takeover Panel waived the requirements of 26.2(b) in relation to the market flex clause for a number of bids; for example, in The Carlyle Group’s offer for the Innovation Group plc, the market flex arrangements were summarised in the scheme document published 16 September 2015 and were not included in the firm intention announcement made on 28 August 2015. The requirement to publish details of the financing documents in the offer or scheme document arises if the debt is not syndicated by that date.
ii Alternative credit providers
Alternative (non-bank) lenders completed 173 primary market deals (at mid-market level) in the first three quarters of 2015, compared to 152 deals completed during the same period in 2014 and 85 over the first three quarters of 2013.18 Alternative lenders are becoming more attractive because they offer more flexibility than traditional bank lenders. Mid-market borrowers can pick and choose a range of financing options such as senior-only structures, US and European term loan B tranches, unitranche, second lien, mezzanine, first out/last out, receivables financing, holdco PIKs or these products in combination. Alternative lenders are becoming more prevalent in the debt financing market and, accordingly, borrowers and advisers are becoming more familiar with them. This increase in market presence has seen non-bank debt funds finance much larger sums in 2015 than ever before. A prime example of this, although outside of the UK, is Eurazeo’s acquisition of Fintrax in November 2015, where Ares provided a €250 million unitranche as part of a €300 million financing package.
iii Innovation in the debt market
An interesting case study for how the buoyant debt market is encouraging flexibility in debt financing is AB InBev’s acquisition of SABMiller. AB InBev made an offer of £44 per share as a partial unlisted share and cash alternative to the cash consideration that would be made up of £3.7788 in cash and 0.483969 NewCo Shares.19 To fund this, the bid was backed by a US$75 million syndicated loan, comprising;
- a a US$25 billion three-year term loan with an option to extend for one-year;
- b a US$10 billion five-year term loan;
- c a US$10 billion one-year disposals bridge facility;
- d a US$15 billion one-year bridge to cash/bond facility; and
- e a US$15 billion one-year bridge to cash/bond facility with an option to extend by one year.
To minimise costs, AB InBev arranged the loan itself through its treasury team in a matter of weeks, and 21 banks formed the syndicate. This is highly unusual for a multi-billion dollar acquisition loan and further demonstrates the liquidity of the debt market that was enjoyed in 2015. AB InBev then raised US$42.5 billion by a bond issue in January 2016 and was able to cancel most of the US$75 million loan with the proceeds.
VII PENSIONS AND EMPLOYMENT LAW
i Holiday pay – liability for potential claims
Holiday pay continues to be a hot topic. In an M&A context, the purchaser will need to consider the potential for historic liabilities where holiday pay has been underpaid, and whether appropriate indemnity protection is required.
The calculation of holiday pay is governed by the concept of ‘a week’s pay’ in Sections 221 to 224 of the Employment Rights Act 1996. The mechanism is complex, and depends on whether the employee’s remuneration varies according to the type or amount of work done. Often employers only use base salary to calculate holiday pay and additional payments such as overtime, bonuses, commission, and allowances are not typically included.
British Airways plc v. Williams was the first case to question this approach, and the European Court of Justice (ECJ)20 and subsequently the Supreme Court21 confirmed that employees were entitled to receive holiday pay that included allowances and supplementary payments that were ‘intrinsically linked’ to the performance of their duties. The ECJ later confirmed in Lock v. British Gas Trading Limited 22 that holiday pay must include an amount in respect of the commission that the employee would have earned had he or she not been on holiday. Bear Scotland Ltd v. Fulton23 then followed, and the Employment Appeal Tribunal held that holiday pay must include an amount in respect of compulsory overtime (i.e., that which the employee is obliged to work if offered by the employer). Most recently in British Gas Trading Limited v. Lock,24 the Employment Appeal Tribunal dismissed British Gas’s appeal against an Employment Tribunal decision that, following the approach adopted by the Employment Appeal Tribunal in Bear Scotland, decided that results-based commission should be included in statutory holiday pay. The Employment Appeal Tribunal refused to reconsider the merits of Bear Scotland, and rejected arguments by British Gas that Bear Scotland was manifestly wrong or that it was incorrectly decided and should not be followed.
These cases still fail to determine how holiday pay should be calculated to include these additional payments – for example, over what reference period the payments should be judged and whether variable pay should be included. British Gas has appealed to the Court of Appeal, and the case was heard on 11 July 2016, so the uncertainty will continue until at least later in the year when the judgment is published.
Businesses initially had concerns that employees would be able to bring retrospective holiday pay claims for a period stretching back to the introduction of the Working Time Regulations in 1998,25 but some comfort was given from the decision in the Bear Scotland case, which decided that retrospective holiday pay claims must be brought within three months of an underpayment of holiday pay, and can only extend to previous underpayments if there is not more than three months between each underpayment. If there is a gap of more than three months, the chain is broken and the claim cannot extend back any further. The Deduction from Wages (Limitation) Regulations 2014,26 which came into force on 8 January 2015 and which apply to claims presented on or after 1 July 2015, also introduced a limitation on historic claims of this sort to the two years preceding the date of the claim.
Although an employer’s exposure has been limited by recent legislation and case law, there will still be some level of exposure in the foreseeable future in industries with atypical remuneration structures or where there is a high proportion of overtime and bonuses, particularly on transactions involving significant numbers of employees. Purchasers should continue to seek an indemnity to cover any potential historic liability for holiday pay.
ii Postponement of minimum contribution rate increases under auto-enrolment
There is mandatory auto-enrolment in the UK. This means that companies are required to offer (most) workers at least a defined contribution tax-registered pension plan providing a minimum level of contributions. Such requirements are being introduced on a ‘staged’ basis – they currently amount to a minimum total contribution of 2 per cent of an employee’s ‘qualifying earnings’27 (of which the employer must contribute at least 1 per cent), rising to 5 per cent from 1 October 2017 (of which the employer must contribute at least 2 per cent) and to 8 per cent from 1 October 2018 (of which the employer must contribute at least 3 per cent). The increasing cost of auto-enrolment will need to be taken into account by purchasers as part of a target’s ongoing employment costs.
The government announced in its 2015 Autumn Statement and Spending Review that the starting dates for the next two transitional periods referred to above will be postponed to 6 April 2018 and 6 April 2019 respectively. By aligning the starting dates of the minimum contribution rate increases to the start of the tax year, the government hopes to ease the administrative burden of auto-enrolment. These proposed dates are subject to parliamentary approval.
However, employers may not currently be able to automatically postpone the starting dates of the minimum contribution rate increases if, for example, they have been specifically written into the scheme rules. The position will need to be checked by the purchaser.
iii Abolition of contracting out for defined benefit schemes: changes now in effect
On 6 April 2016, contracting out of the state pension in defined benefit schemes was abolished as part of the introduction of the reformed UK state pension system. Employers have therefore lost the national insurance rebate that they were previously entitled to as result of contracting out of the state pension.
The abolition of contracting out could be a relevant consideration for those purchasers considering taking on a target’s (now formerly contracted out) defined benefit scheme that is still open to future accrual (although such schemes are now rare), as the employer would be required to pay a higher level of national insurance contributions.
However, a statutory modification power has been introduced that allows employers unilaterally to amend scheme rules governing accrual rates and member contribution levels so far as is necessary to compensate the employer for the loss of its national insurance rebate. This power is subject to certain restrictions and would require consultation with employees. The power will be available for five years after the abolition of contracting out.
iv Transfers of past service benefits
A seller may require the purchaser to continue to offer a target’s employees membership of a defined benefit pension scheme, including accepting a transfer of the employees’ (and possibly former employees’) past service benefits into that scheme, although this is now relatively unusual.
It may not currently be possible to carry out a transfer of such past service benefits following the abolition of contracting out on 6 April 2016. If a transfer is to be carried out on a ‘without consent’ basis,28 certain requirements must be met. Currently, these requirements mean that where a formerly contracted-out defined benefit scheme is seeking to transfer any contracted-out benefits, it is only able to make such transfer to another formerly contracted-out defined benefit scheme. On acquisitions, transfers would usually be made with members’ consent, but they could be made on a without-consent basis, particularly if it is intended to also transfer the benefits of any former employees.
The UK Association of Pension Lawyers has raised the difficulties created by the above situation, and has suggested that schemes that are not formerly contracted out should be able to receive such transfers on the proviso that other sufficient protections are in place. The UK Department of Work and Pensions has accepted the logic of this suggestion but, given the complexities of enacting it, may not make the required changes to the legislation for some time. The current expectation is that the required changes to legislation will not be made until some time in 2017.
VIII TAX LAW
The UK is, according to the government, ‘open for business’. In March 2016, the business tax roadmap was released, which sets out changes to business tax over the next four years. The guiding principle is said to be encouraging investment while tackling avoidance.
i Encouraging investment in debt and equity
To strengthen the UK’s private placement market, a new exemption for withholding tax on private placement debt came into force on 1 January 2016. It is understood that lending under the Loan Market Association standard facility agreement will, notwithstanding its name, also be accepted by HMRC as falling within this exemption, but it is hoped that HMRC guidance will confirm expressly that the exemption is intended to apply to syndicated facilities.
Equity investments by individuals are encouraged by an extension of entrepreneurs’ relief to long-term investors investing in unlisted trading companies, and a reduction in capital gains tax rates from 28 to 20 per cent (for higher rate taxpayers) and 18 to 10 per cent (for basic rate taxpayers). This rate reduction will not, however, apply to carried interest. Indeed, the circumstances in which payments of carried interest will be treated as income rather than capital (and therefore be subject to tax at a higher rate) have been further extended after the introduction of the disguised investment management fee rules as part of Financial Act 2015 (FA 2015). This is obviously unwelcome news for the private equity sector, and should be considered when structuring management participation in investments.
On 26 May 2016, the government published a consultation on the substantial shareholdings exemption (SSE) under which capital gains on corporate share disposals are not subject to UK corporation tax. The consultation asks for views on overarching changes to the structure of the SSE (such as an abolition of the trading requirement) and invites comments on a proposal to introduce changes targeted at the funds sector. It also covers detailed design modifications (for instance, amending the application of the holding period rules in the case of investments being disposed of in tranches). However, the overall tone of the consultation seems to suggest that only limited changes should be required.
ii The UK as domicile of choice
The UK continues to be an attractive destination from a tax perspective. For instance, insurance group Beazley plc returned to the UK in April 2016 after having moved its tax residence to Ireland in 2009.
The move was said to have been motivated by the government’s commitment to continue to reduce tax rates to drive growth. From 2020, the corporation tax rate will be only 17 per cent, which will be by a margin the lowest rate in the G20 (but will not, it is thought, trigger any switch-over provisions enacted pursuant to the proposed EU Anti-Tax Avoidance Directive).29
To align the UK tax system with other G7 countries, the government proposes that losses incurred on or after 1 April 2017 can be carried forward and set off against profits from other income streams or group companies – losses incurred before that date and carried forward will remain deductible only from profits of the same activity. From the same date, however, the amount of taxable profit that can be offset by carried-forward losses is to be restricted to 50 per cent once carried-forward losses of more than £5 million have been used across a group in the relevant year. Stricter restrictions will apply to banks, limiting the amount of profits against which carried-forward losses can be offset to 25 per cent from 1 April 2016.
As required under base erosion and profit shifting (BEPS) Action 4, the government intends to restrict, from 1 April 2017, corporation tax deductions for net interest expenses to 30 per cent of a group’s UK EBITDA or, if higher, to the net interest to EBITDA ratio for the worldwide group. The provision of private finance for certain public infrastructure in the UK will be excluded, as also envisaged in Action 4, and the government is considering a modified application of the new rules to regulatory capital. The new rules will take effect from 1 April 2017, and will clearly have an impact on the hitherto standard procedure of introducing additional debt into the UK when a UK group is acquired.
iii Oil and gas
The government has taken further action to help a sector that is in deep trouble following the drastic drop in oil prices. After FA 2015 contained a package of changes designed to encourage investment in UK oil and gas, Budget 2016 announced an even more radical package of rate cuts and reliefs.
The ‘supplementary charge’ will be reduced from 20 to 10 per cent (such that the total rate of corporation tax on ‘ring-fence’ profits is 40 per cent) and the rate of petroleum revenue tax (PRT) will be reduced from 35 to zero per cent. (PRT is not abolished altogether, because otherwise companies that decommission fields that have paid PRT would not be able to benefit from decommissioning relief in respect of the PRT.) In addition, ring-fence profits will not be subject to the proposed restrictions on interest deductions and the use of carried-forward losses.
From 1 April 2015, a new ‘diverted profits tax’ took effect; it remains unclear whether it would survive a challenge before the Court of Justice of the European Union, and the Internal Revenue Service continues to consider whether it (and other BEPS-like taxes and repayments of state aid) would be creditable against US taxes.
Budget 2016 announced entirely unexpected changes to the rules on withholding tax on royalties to counter avoidance using intragroup royalty payments to shift profits from the UK to low or no-tax jurisdictions, either directly or via a third country. The proposals are controversial because, if they are legislated in the form in which they were announced, they will, in certain situations, entitle the UK to tax on income in excess of that generated by UK activity.
The UK is also implementing legislation to counter ‘hybrid mismatches’ with effect from January 2017 following the BEPS Action 2 recommendations. This, too, could have a significant impact, although, once the cap on interest deductions is introduced, the demand for hybrid structures is expected to fall, anyway (see subsection ii, supra).
v Transparency and tax disclosure
UK regulations to implement country-by-country reporting came into force in March 2016, and the UK’s register of beneficial ownership was put in place on 30 June 2016, with information being free and publicly available.
Large UK groups, companies, partnerships and UK permanent establishments of foreign entities will also be required to publish their tax strategy annually on the internet.
In Airtours,30 the Supreme Court decided that Airtours could not recover input tax on PwC fees, since PwC’s supplies had been made to the financing banks (who were the addressees of PwC’s report and engagement letter) and not to Airtours itself. This highlights the importance of considering in advance the appropriate recipient of VATable supplies in a multiparty commercial context. It is notable, too, that the courts have yet to develop a comprehensive set of principles regarding the attribution of input tax to activities, such as the issue of shares, which are outside the scope of VAT.
IX COMPETITION LAW
i The UK merger regime
The Competition and Markets Authority (CMA)31 has the power to carry out an initial Phase I review, and has a duty to refer any qualifying transaction for a detailed Phase II investigation where it believes that it is or may be the case that the merger could give rise to a substantial lessening of competition. Phase I decision making is undertaken by the Senior Director of Mergers (or another senior CMA official). Phase II decision-making is undertaken by an independent panel of experts drawn from a pool of senior experts in a variety of fields.
Notification is ‘voluntary’ in the sense that there is no obligation to apply for CMA clearance before completing a transaction. The CMA may, however, become aware of the transaction through its market intelligence functions (including through the receipt of complaints) and impose interim orders preventing further integration of the two enterprises pending its review. There is a risk that it may then refer the transaction for a Phase II investigation, which could ultimately result in an order for divestment.
The CMA strongly encourages parties to enter into pre-notification discussions in advance of formal notifications in order to seek advice on their submission, to ensure that a notification is complete and to also lessen the risk of burdensome information requests post-notification. In its Annual Plan 2015/16, the CMA stated its aim to start the statutory clock within 20 working days (on average across all cases) of a submission of a substantially complete draft merger notice. The CMA appears to be meeting its target: during the 2015–2016 financial year, pre-notification took on average 10 working days, compared to 25 working days in the preceding year.32 Some cases, however, still do require long pre-notification periods. Once a transaction is formally notified, Phase I begins, and the CMA has a statutory time limit of 40 working days to reach a decision. It may, however, extend this period in certain exceptional circumstances, such as if it is waiting for information from the merging parties. The CMA can obtain information at Phase I through formal information-gathering powers with penalties for non-compliance. The CMA formally paused the statutory timetable in 12 per cent of Phase I cases during the 2015–2016 financial year.33
During the 2015–2016 financial year, the CMA completed 100 per cent of cases within the Phase I statutory deadline.34 The average length of Phase I was 34 working days, and the CMA claims that 74 per cent of less-complex mergers were cleared in 35 working days or less (and some in significantly less time).35 Where the CMA’s duty to refer a transaction to a Phase II investigation is engaged, the parties have five working days from the substantial lessening of competition decision (SLC decision) to offer undertakings in lieu of a reference to the CMA (although they may offer them in advance should they wish to do so). Where the parties offer undertakings, the CMA has until the 10th working day after the parties received the SLC decision to decide whether the offer might in principle be acceptable as a suitable remedy to the substantial lessening of competition. If the CMA decides the offer might in principle be acceptable, a period of negotiation and third-party consultation follows. The CMA is required to decide formally whether to accept the offered undertakings, or a modified form of them, within 50 working days of providing the parties with the SLC decision, subject to an extension of up to 40 working days if there are special reasons for such extension.
At Phase II, the CMA must issue its decision within a statutory maximum of 24 weeks, extendible in special cases by a period of up to eight weeks. Where remedies are required, the CMA has a statutory period of 12 weeks (which may be extended by up to six weeks) following the Phase II review within which to make a decision on any remedies offered by the parties.
The CMA has significant powers to impose interim measures to suspend or reverse all integration steps and prevent pre-emptive action in relation to both completed and anticipated mergers. This ensures that, while notification is voluntary in the UK, the CMA is able to prevent action being taken that would result in irreversible damage to competition. Severe financial penalties may be imposed for breaches of any interim orders or undertakings (capped at 5 per cent of the aggregate group worldwide turnover).
The CMA levies substantial filing fees in respect of the mergers it reviews, with fees of between £40,000 and £160,000, depending on the turnover of the target business.
ii Treatment of mergers by the CMA
The number of Phase I merger decisions made by the CMA in the 2015–2016 financial year (62) was down from the 82 decisions taken in the preceding financial year, and significantly down from the peak of 210 merger decisions made by the OFT in the 2005–2006 financial year.
Of the 62 cases decided during the year, 40 were cleared unconditionally, representing around 65 per cent of cases, down from 77 per cent in the preceding year (including cases cleared under the de minimis exception). Eleven cases were referred for Phase II review, which is around 18 per cent of cases, up from 7 per cent in the preceding year. Undertakings in lieu of a reference were accepted in nine cases, up from three in the preceding year.
At the time of writing, four of the 11 transactions referred to Phase II have been cleared unconditionally, two have provisionally been found to give rise to a substantial lessening of competition, two are still under review and three have been abandoned.
A total of nine Phase II decisions were published by the CMA in the 2015–2016 financial year, up from three published by the CMA in the previous year. Eight were unconditional clearances, and one permitted the transaction to proceed subject to behavioural remedies. As was the case in the preceding year, the CMA did not prohibit any mergers during the 2015–2016 financial year.
Overall, the CMA intervened (i.e., prohibited or accepted remedies) in around 14 per cent of cases in the 2015–2016 financial year, which is around twice the rate of intervention from the European Commission over the same period. The higher intervention rate may be explained by the voluntary nature of the UK merger control regime, which means that parties may elect not to notify transactions that do not give rise to significant competition issues.
iii Recently published statements and consultations relevant to mergers
In its Annual Plan 2016/17, published in March 2016, the CMA stated its aim to further increase the pace, scale and impact of its interventions. In particular, it announced two new targets for its assessment of mergers: to implement Phase II merger remedies without the need for an extension to the statutory deadline in at least 70 per cent of cases, and to clear at least 70 per cent of merger cases that are less complex within 35 working days (a target that was met in the last financial year). The CMA also announced that during 2016 and 2017, it will review its policy and procedure in relation to accepting undertakings in lieu, and may consult on revised guidance on its application of any of the exceptions to the duty to refer. The CMA will also launch an internal project to consider the use of formal information-gathering powers at both phases across its mergers portfolio, and will publish guidance on how to interact with the CMA on non-notified mergers (including the operation of its mergers intelligence work).
On 25 May 2016, the Department for Business, Innovation & Skills launched a consultation on refinement options for various elements of the UK competition law regime, including merger control. The consultation notes the CMA’s intention to improve the merger control process, but also refers to concerns raised by some stakeholders in relation to information requirements, inefficiencies between Phase I and Phase II investigations, and the intrusiveness of hold-separate undertakings. The consultation therefore sets out a number of proposals and options for reform, including:
- a developing guidance on the type and frequency of information requested by the CMA, and potentially introducing legislative changes to support the guidance;
- b publishing guidance on the CMA’s approach to initial enforcement orders and derogations to these in order to provide more certainty to businesses; and
- c improving Phase II review structures, including refining decision-making arrangements and improving the current panel system.
The government intends to publish its response to the consultation by autumn 2016, setting out which, if any, of the options it intends to take forward.
2015 was a bumper year for global M&A. Deal values across Europe topped €1 trillion, and the UK was at the epicentre of this activity. The ghosts of the financial crisis, if not completely shed, certainly were not at the forefront of dealmakers’ minds. With cheap financing and a weaker pound, the UK saw a large amount of inbound M&A. Market participants were even prepared to ignore the problems plaguing the eurozone.
However, 2016 has not had such a rosy start. Markets were preoccupied with the referendum on the UK’s membership of the EU, worried that a vote to leave would lead to an immediate recession. This lack of confidence has certainly hit dealmaking. However, it is interesting to note that the standout deal of the year so far is Deutsche Boerse’s takeover of London Stock Exchange, which, despite having a significant European dimension, is not subject to any condition on the UK’s continuing membership.
Despite the obvious shock of the leave vote in the UK’s referendum on continued membership of the EU, there are reasons to be cautiously optimistic about the M&A market in the second half of the year. Interest rates remain low and, with the rise of alternative credit providers, there are more sources for companies to raise acquisition financing from than at any other time since the financial crisis. The fall in the value of the pound has also made any foray into public M&A cheaper for foreign investors. However, it is likely that markets will be preoccupied by the fallout of the leave vote for some time. It is not clear what Brexit means for the UK’s access to the European single market and what the terms of any future trade deals might be. As such, M&A is unlikely to be as buoyant as it was this time last year, but for those companies keen to capitalise on the developing situation, there will be plenty of opportunities.
1 Mark Zerdin is a partner at Slaughter and May. The author would like to thank Christopher McCabe for his assistance in preparing this chapter.
2 Mergermarket Deal Drivers, EMEA 2015.
3 PLC, Public M&A Trends and Highlights 2015.
4 Mergermarket Deal Drivers, EMEA 2015.
5 Deloitte CFO Survey Q1 2016.
6 PLC, Public M&A Trends and Highlights 2014.
7 ONS Labour Productivity: Oct to Dec 2015.
9 EY, UK Attractiveness Survey 2015, Executive Summary.
10 Office for National Statistics statistical bulletin: Mergers and Acquisitions involving UK companies: Quarter 4 October to December 2015.
11 EY, UK Attractiveness Survey 2015, ‘But there are worrying signs for the future […]’.
12 EY, UK Attractiveness Survey 2015, ‘Emerging growth […]’.
13 ‘Apple cash move will not end EU tax probe’, Financial Times, 10 April 2016.
14 ‘London Stock Exchange, Deutsche Boerse Agree on Merger’, Bloomberg 16 March 2016.
15 ‘AB InBev makes formal £71bn bid for SABMiller’, Financial Times, 11 November 2015.
16 PLC Public M&A Trends and Highlights 2015.
17 PLC Public M&A Trends and Highlights 2014.
18 DLA Piper, Acquisition Finance Debt Report 2015.
19 DLA Piper, Ibid.
20  EUECJ C-155/10.
21  ICR 1375.
22  EUECJ C-539/12.
23  UKEATS/0047/13/BI, UKEAT/0160/14/SM.
24 UKEAT 0189/15.
25 SI 1998/1833.
26 SI 2014/3322.
27 The contribution rates do not apply to all of the employee’s pay, but only to the amount falling within the ‘qualifying earnings band’. For the 2016/17 tax year, qualifying earnings are gross annual earnings between £5,824 and £43,000.
28 That is, without the consent of the members whose benefits are to be transferred.
29 See Section IV of the EU Overview chapter.
30  UKSC 21.
31 On 1 April 2014, the CMA assumed the competition powers and responsibilities of the Office of Fair Trading (OFT) and the Competition Commission as part of a series of reforms intended to strengthen the UK merger control regime.
32 Speech by Alex Chisholm on the CMA’s achievements over the past two years, 11 May 2016.
35 Speech by Alex Chisholm on the CMA’s achievements over the past two years, 11 May 2016, and ‘Mergers: A year in review’, Law Society Competition Section seminar, 8 March 2016. For example, Nikkei/FT was cleared in 10 working days, Heineken/Diageo in 20, NSMP/Total in 21, Aviator/Swissport in 22 and Netto/Co-op in 23.